Gap may be headed for trouble in 2013

Commentary: This retail emperor has no clothes

By

MargaretBogenreif

CHICAGO (MarketWatch) — Investors are in love with Gap Inc. this holiday season, and it’s easy to see why.

After all, 2012 numbers have screamed “turnaround success” for the onetime retail darling. Sartorially, for the fist time since defining the khaki culture of the 1990s, Gap
GPS, +1.19%
seemingly had found its fashion groove this year, hitting the coveted 25- to 40-year-old female consumer’s sweet spot with a trendy warm-weather line that featured items — e.g., brightly colored, thin-fabric Capri pants — of which women couldn’t seem to get enough.

And September 2012 brought with it excellent revenue news. With same-store sales increasing 6%, the month led into a successful October. Gap reported a 4% pop in same-store sales last month, topping off a successful third quarter for the retailer, with total net sales increasing 5.6% overall. Read New York Times story on Gap’s ‘fresh coat of pep.’

All this, then, combines to make Gap appear to be the feel-good story, with the company’s stock price confirming popular sentiment: Since last September, Gap’s stock price has more than doubled, moving from approximately $16/share to approximately $35 as of this writing.

Despite the good news, however, this retail season will soon demonstrate that this retail emperor has no clothes. Here’s why:

One successful season does not a turnaround make

Positive press and a jump in valuation started around March of this year, when Gap stumbled upon its first successful spring line in years. A successful line, combined with one of the warmest spring/summer/autumn blended seasons in history, meant an unexpected and prolonged increase in revenue for the retailer in 2012.

What most failed to recognize, however, is that little has changed strategywise for Gap in recent years.

Right strategy, wrong time

Investors cheered when Gap executives recently announced plans for expansion of its three core brands — Banana Republic, Old Navy and Gap — into China in 2013. Much like the brand’s push into Europe just as the continent was teetering on the brink of the economic abyss in which it still finds itself, Gap’s timing could hardly be worse.

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Political unrest, demographic issues and a stalled global economy, plus the fact that the country has experienced a 30% decrease in demand for durable goods this year, indicate that China sits on the precipice of, if not an economic contraction, then at least a stalled economy. Just as Gap seeks its yuan, China’s middle class will most likely have far less to spend next year on the brand’s casual chic clothing.

Competition

Having lost its way in the 2000s, Gap found itself listing about, having lost its market share to the better-run J. Crew, rapidly growing fast-fashion giants H&M
HMB, +0.85%HNNMY, +1.02%
and Forever 21 and, most recently, the popular Uniqlo
9983, -0.90%
While fast-fashion giants continue to siphon off Gap’s market share, it’s up-and-comers like Uniqlo that most seriously threaten the San Francisco–based retailer.

In fact, Uniqlo recently, just in time for the holiday season, launched an easily accessible and highly popular website in the U.S. featuring the brand’s trendy yet moderately priced clothing lines. This move proves that the Japanese behemoth is set on openly gunning for Gap’s core consumer now and in 2013.

Holiday sales are not enough

Finally, Gap is looking to the holiday season to make up for a sluggish half-decade. In that, it’s not alone. With experts predicting a middling 3% increase in U.S. chain-store sales this year, Gap’s reliance on seasonal spending both belies the retailer’s struggle for growth and profitability and its dependence upon one-time sales boosts (as opposed to a coherent strategy) to steady (instead of enhance) brand performance.

So, given all the upbeat ink spilled this year by reporters and analysts alike about the Gap, what’s an investor to think?

Make no mistake: Regardless of a seemingly successful 2012, Gap Inc. is likely headed for trouble in 2013. Limited growth potential, combined with a confused and mistimed expansion strategy and a dependence on “one-season” popular items/holiday sales, means the company is inclined to confront a sluggish, retrenching year in 2013.

Gap did not respond to a request for comment on this column.

Perhaps most importantly — on the macro-strategy side, anyway — until the retailer fully commits to a comprehensive turnaround plan (and finally sells or spins off the underperforming Old Navy brand, thereby allowing the Gap brand “breathing room” under Banana Republic), investors should be wary of long-term growth and profitability prospects for Gap Inc. After all, this is a brand for which simple momentum has contributed most to its “success” and survival in the past decade.

In short, don’t call 2012 a comeback. Gap’s struggles have been here for years. And will continue to be for many more.

Margaret Bogenriefis a partner withACM Partners, a boutique financial advisory firm in Chicago, providing due diligence, performance improvement, restructuring and turnaround services. She does not have a position in any of the stocks mentioned in this column.

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